INTEREST RATE SWAPs AND CURRENCY SWAPs

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BHARAT MUNIM 35

MAHUL NAGDA 36

PRANAY NARVEKAR 38

DOLLY PAREKH 39

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HP COMPAQ

INTRINSIC VALUE $50 billion $31.5 billon

NO. OF EQUITY SHARE

HOLDERS

1 billion 1billion

VALUE PERSHARE $50 $31.5

SWAP RATIO 1 0.63

HP HPQ COMPAQ1 share 0.63 share

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Agreement between 2 parties to exchange

cash flows in future

Riskiness of the transactions

First swap- negotiated in 1980s

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Exchange ofa stream of interest payments

for other partys stream of cash flows.

Used by hedgers

Used by speculators

Highly liquid instruments

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Structure of Interest Swaps:

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Illustration: A hypothetical 3-year swap initiated on March 5, 2010.

Semi-annual interest payments.

Tata Motors Ltd agrees to pay Maruti Udyog Ltd a fixedinterest rate of 8% per annum.

Maruti agrees to pay 6-month LIBOR rate to Tata.

Notional principle amount of Rs 100 crores.

Maruti

Udyog Ltd

Tata

Motors

Ltd

8.00%

LIBOR

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Date 6-months

LIBOR rate

(%)

Floating cash

flow received

Fixed Cash flow

received

Net cash flow

March, 5, 2010 7.6%

September 5, 2010 7.8% +380 -400 -20

March, 5, 2011 8.0% +390 -400 -10

September 5, 2011 8.1% +400 -400 0

March, 5, 2012 8.2% +405 -400 +5

September 5, 2012 8.4% +410 -400 +10

March, 5, 2013 8.5% +420 -400 +20

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Using a swap to transform a liability

Maruti

Udyog Ltd

Tata

Motors Ltd

8.3%8.00%

LIBOR

LIBOR+0.2%

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Using a swap to transform an asset:The process remains the same.

Maruti Udyog

Ltd

Tata Motors

Ltd

8.3% 8.00%

LIBOR

LIBOR+0.2%

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Overview

Structure

Illustration

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Agreement to exchangeloan

Long term financing or hedging technique

Right to offset Non-payment

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It is a series of Forward Contracts.

A currency swap is not a loan therefore does

not changes theliability structure of the

parties.There is an exchange ofPrincipal(unlike for

interest rate swaps)

The initialvalue of the contract is Zero.

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2.4mEuro $4.16m

$52m

Euro

BondMkt

US

BondMkt.

Microsoft(USMNC)

LuftahnsaAirlines(German MNC)

Luftahansa(USSubs)

Microsoft(GermanSubs)

Swap Bank(F.I)

$52m

@8%(5yrs)

40m

euro@6

%(5yrs)

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PrincipalExchange-Directly

Interest Exchange through Swap Bank

Com

parative

A

dv

antage

USCo. saves 1% on $5,20,000 over 5 yrs

German Co. saves 1% on 4,00,000 Euro over5 yrs

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SecureCheaper Debt

Hedge against risk

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Valuation with an e.g.

Other currency swaps (cross currency swap)

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